Thursday 23 November 2017

ECB has succumbed to delusion in its approach to growing crisis

Much has been written about flaws in the design of the monetary union and about the need for a deeper fiscal and political union. And some permanent reforms of the euro system are planned. But these will not resolve the crisis at hand.

So what is preventing agreement on a permanent and comprehensive solution to the problem?

Governments in the eurozone need to realise that the dynamics of inter-country dependence have changed with monetary union and that, accordingly, national priorities must develop. Moreover, the institution that embodies the monetary union -- the ECB -- needs to take a lead both in sending this message and in crafting a practical response that could be supported from this evolved national perspective.

There are three stages of political maturity in economic co-operation.

First, there is primary school, where we all get to know one another, are (mostly) very nice to one another and go to one another's birthday parties. We learn to co-operate because this might elicit a co-operative response from others in the future. Mr Sarkozy, for example, is an avid attendee at such celebrations -- but be warned, he may not come to yours if you do not go to his.

The second stage is discovered in team sports in the teenage years and in the realisation that we actually depend on one another for mutual prosperity. Mr Schäuble, the German finance minister, finally lifted the crisis narrative to this level last week when he made a strong case to the Bundestag that Germany needs the euro. Recalling that Germany is the leading exporter in the eurozone, he reminded members that because "we have the greatest benefit, we also have the greatest responsibility".

His refreshing candour was probably as important as his proposal for a 'soft' restructuring of Greek debt. But even the brave Mr Schäuble could not fully stand up to the ECB and insist that the debt restructuring be tougher. This would involve a recognition that, for the system to survive and prosper as a whole, some short-term individual sacrifice is sometimes required. This third and final stage sees the mature adult don a uniform and fight for the preservation of his system and society.

The IMF knows about the value of such sacrifice for the future and that is why it has been so critical of the lack of support from Europe for the crisis countries. In particular, these countries need access to bank lending if they are to grow, but all three are shut out from markets. An ISME survey this week confirmed that more than half of Irish firms are being refused bank credit.

The solution requires that the ECB takes some calculated risks. At the very least, it could support banks in peripheral countries by offering medium-term credits. As pointed out here last week, the European System of Central Banks has earned gold profits of €305bn to add to its €80bn in capital, and can well afford to take a hit if required. And selective credits, if properly applied as part of an IMF programme, need not undermine monetary control (as feared by Mr Draghi this week).

Bloomberg describes how Ben Bernanke of the Federal Reserve "made unprecedented use of the Fed's powers as the lender of last resort to contain the worst erosion of credit since the Great Depression . . . (keep) banks liquid by accepting bonds they can't trade as collateral ... (and) ... bailed out the nation's biggest insurer." His leadership worked.

In sharp contrast, a stock speech by Mr Trichet this week reaffirmed the ECB's record in fighting inflation, while giving temporary support to banks; reiterated that price stability was important for economic growth; and claimed that the euro area is as stable as the dollar area.

In truth, the ECB has consistently rejected any solutions proposed by others; has offered no solutions of its own to this crisis; and has finally succumbed to delusion.

Yes, a rescue package will emerge at the last minute and Greece will dodge a formal declaration of insolvency. But pressure on private lenders to stretch their loans has offended rating agencies who may consider it an effective default. The Greek government will be funded for another year or so but European leaders have raised the spectre of default without securing the advantages of a real debt restructuring. So they will be back to the issue of an insolvent Greece next spring, just as surely as the mimosa will bloom.

The package will be sufficient to protect the core from losses in the periphery but not generous enough to reignite growth in the periphery.

And even though the failing European response continues to undermine credibility in our own recovery programme, Ireland needs to act in an adult manner and to implement the tough reforms that are needed anyway.

In the meantime, we can only hope that our European partners mature into an understanding that they will need to accept temporary losses in order to give the periphery a chance and to preserve the euro.

Gary O'Callaghan is professor of economics at Dubrovnik International University. He was a member of the staff of the IMF and has advised governments on macroeconomic policies.

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